**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC 20549**

 

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**AMENDMENT NO. 2 TO FORM 10-Q**

 

**Mark One**

 

**ý****        ****Quarterly Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

**for the Quarterly Period Ended June 30, 2004.**

 

**or**

 

**o****        ****Transition Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

**for the Transition Period From               To              ..**

 

**Commission file number: 000-25755**

 

**WORLDGATE COMMUNICATIONS, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 
| **Delaware**                                   | ** ** | **23-2866697**                       |
|------------------------------------------------|------------|--------------------------------------|
| (State of Incorporation)                       |       | (I.R.S. Employer Identification No.) |
| ** **                                     | ** ** | ** **                           |
| **3190 Tremont Avenue  Trevose, Pennsylvania** | ** ** | **19053**                            |
| (Address of Principal Executive Offices)       |       | (Zip Code)                           |

 

**(215) 354-5100**

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes ý No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).   Yes o No ý

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).   Yes o No ý

 

As of August 6, 2004, therewere 28,225,590 shares of common stock, par value $.01 per share, outstanding.

 

 

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**EXPLANATORY NOTE**

 

WorldGateCommunications, Inc. (the “Company”) is filing this Amendment No. 2 on Form10-Q/A to amend its Quarterly Report on Form 10-Q for the quarter ended June30, 2004, as filed with the Securities and Exchange Commission (the “SEC”) onAugust 16, 2004 (the “Original Filing”) and as first amended on November 17, 2004 (the “Amended Filing”).  The purpose of this Amendment No. 2 is toamend and restate Part I, Item 1 and Item 2 which set forth the accounting forthe warrants and additional investments rights issued in private placements ofthe Company’s common stock during the fourth quarter of 2003 and the firstquarter of 2004.  These securitycomponents were originally treated as non-cash expenses and with this amendmentare being restated as equity transactions. Accordingly, changes have been madeto the applicable line items associated with additional paid-in capital,accumulated deficit, general and administrative costs, net loss and net lossper common share.  In addition, Part I,Item 1, Item 2, Item 3 and Item 4 and Part II, Item 2 and Item 6 have beenamended and restated to reflect certain clarifications made in response to theSEC’s comments as raised in its review of the Company’s registration statementon Form SB-2/A2, as filed with the SEC on May 24, 2005, and annual report onForm 10-K for the year ended December 31, 2004, as filed with the SEC on March31, 2005, and subsequent review of the Company’s registration statement on FormSB-2/A, as filed with the SEC on August 30, 2005, and annual report on Form10-K/A for the year ended December 31, 2004, as filed with the SEC on August30, 2005. Finally the certifications attached as Exhibits 31.1, 31.2, 32.1 and32.2 have been updated to reflect the filing date of this amendment and interimchanges in the regulations applicable to these certifications.  Except as described above, no additions ormodifications have been made to this Amendment No. 2 to reflect facts or eventsoccurring subsequent to the date of the Original Filing or the Amended Filing.

 

2

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WORLDGATE COMMUNICATIONS, INC.

 

QUARTERLY REPORT ON FORM 10-QA

FOR THE THREE MONTHS ENDED JUNE 30, 2004

 

TABLE OF CONTENTS

 
| PART  I. FINANCIAL INFORMATION                                                                       |   |   |
|------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                 |   |   |
| Item 1. Financial Statements                                                                         |   | 4      |
| Item 2. Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations. |   | 15     |
| Item 3. Quantitative And  Qualitative Disclosures About Market Risk.                                 |   | 20     |
| Item 4. Controls And Procedures.                                                                     |   | 20     |
|                                                                                                 |   |   |
| PART II. OTHER  INFORMATION                                                                          |   |   |
|                                                                                                 |   |   |
| Item 1. Legal Proceedings.                                                                           |   | 21     |
| Item 2. Changes In  Securities And Use Of Proceeds.                                                  |   | 21     |
| Item 3. Defaults Upon Senior  Securities.                                                            |   | 22     |
| Item 4. Submission Of  Matters To A Vote Of Security Holders.                                        |   | 22     |
| Item 5. Other Information.                                                                           |   | 23     |
| Item 6. Exhibits And Reports  On Form 8-K.                                                           |   | 24     |

 

3

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PARTI. FINANCIAL INFORMATION

# ITEM1.  FINANCIAL STATEMENTS

 

**WORLDGATE COMMUNICATIONS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Dollars in Thousands)**

 
| ** **                                                                                                                                                                                | ** ** | **As of  June 30,  2004**        | ** ** | **As of  December 31,  2003**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **(Unaudited and  as restated)** | ** ** | **(Audited and as  restated)** | ** ** |
| ASSETS                                                                                                                                                                                    |       |                             |       |                           |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Current assets:                                                                                                                                                                           |       |                             |       |                           |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Cash and cash equivalents                                                                                                                                                                 |       | $                                | 10,306     |                           | $          | 3,365 |   |
| Accounts receivable, less allowance for  doubtful accounts of $0 at June 30, 2004 and $381 at December 31, 2003                                                                           |       | 102                              |       | 146                            |       |
| Prepaid and other assets                                                                                                                                                                  |       | 348                              |       | 199                            |       |
| Total current assets                                                                                                                                                                      |       | 10,756                           |       | 3,710                          |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Property and equipment                                                                                                                                                                    |       | 2,635                            |       | 2,605                          |       |
| Less: accumulated depreciation and  amortization                                                                                                                                          |       | (1,541                           | )          | (1,338                         | )          |
| Property and equipment, net                                                                                                                                                               |       | 1,094                            |       | 1,267                          |       |
| Deposits and other assets                                                                                                                                                                 |       | 0                                |       | 140                            |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Total assets                                                                                                                                                                              |       | $                                | 11,850     |                           | $          | 5,117 |   |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                 |       |                             |       |                           |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Current Liabilities:                                                                                                                                                                      |       |                             |       |                           |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Accounts payable                                                                                                                                                                          |       | $                                | 146        |                           | $          | 440 |   |
| Accrued expenses                                                                                                                                                                          |       | 1,072                            |       | 594                            |       |
| Accrued compensation and benefits                                                                                                                                                         |       | 278                              |       | 238                            |       |
| Dividend payable on Preferred Stock                                                                                                                                                       |       | 7                                |       | 0                              |       |
| Detachable warrants                                                                                                                                                                       |       | 1,723                            |       | 0                              |       |
| Notes payable                                                                                                                                                                             |       | 256                              |       | 0                              |       |
| Conversion option on Preferred Stock                                                                                                                                                      |       | 2,247                            |       | 0                              |       |
| Deferred revenues                                                                                                                                                                         |       | 300                              |       | 0                              |       |
| Deferred rent credit                                                                                                                                                                      |       | 150                              |       | 30                             |       |
| Total current liabilities                                                                                                                                                                 |       | 6,179                            |       | 1,302                          |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Deferred rent credit                                                                                                                                                                      |       | 0                                |       | 135                            |       |
| Total liabilities                                                                                                                                                                         |       | 6,179                            |       | 1,437                          |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Redeemable Preferred Stock                                                                                                                                                                |       | 2,816                            |       | 0                              |       |
|                                                                                                                                                                                      |       |                             |       |                           |       |
| Stockholders’ equity:                                                                                                                                                                |       |                             |       |                           |       |
| Preferred Stock, $.01 par value, 13,500,000  shares authorized                                                                                                                            |       | 0                                |       | 0                              |       |
| Redeemable Preferred Stock, $.01 par value,  shares authorized, 7,550 shares issued and outstanding at June 30, 2004, and  0 outstanding at December 31, 2003                             |       | 0                                |       | 0                              |       |
| Common stock, $.01 par value, 50,000,000  shares authorized, 28,225,590 shares issued and outstanding at June 30, 2004  and 25,706,843 shares issued and outstanding at December 31, 2003 |       | 282                              |       | 262                            |       |
| Additional paid-in capital                                                                                                                                                                |       | 204,999                          |       | 201,766                        |       |
| Unearned compensation                                                                                                                                                                     |       | (400                             | )          | (400                           | )          |
| Accumulated deficit                                                                                                                                                                       |       | (202,026                         | )          | (197,943                       | )          |
| Less Treasury Stock, at cost — 0 and  500,000 shares as of June 30, 2004 and December 31, 2003, respectively                                                                         |       | 0                                |       | (5                             | )          |
| Total stockholders’ equity                                                                                                                                                           |       | 2,855                            |       | 3,680                          |       |
| Total liabilities and stockholders’ equity                                                                                                                                           |       | $                                | 11,850     |                           | $          | 5,117 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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**WORLDGATE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

**(Dollars in Thousands, Except per Share Amounts)**

 
| ** **                                                                                                                                                                                                                                        | ** ** | **Three Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                                                                        | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                                                                                        | ** ** | ** **                           | ** ** | ** **                         | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| Revenues from operating activities of  continuing operations                                                                                                                                                                                      |       | $                                    | 0          |                               | $          | 0 |   | $ | 0 |   | $ | 0 |   |
| Engineering and development (excluding  depreciation and amortization amounts of $102 and $76 for the three months  ended June 30, 2004 and 2003, respectively, and $204 and $220 for the six  months ended June 30, 2004 and 2003, respectively) |       | 799                                  |       | 727                                |       | 1,599 |   | 1,263 |   |
| Sales and marketing (excluding depreciation  and amortization amounts of $0 and $24 for the three months ended June 30,  2004 and 2003, respectively, and $0 and $50 for the six months ended June 30,  2004 and 2003, respectively)              |       | 408                                  |       | 139                                |       | 599 |   | 225 |   |
| General and administrative (excluding  depreciation and amortization amounts of $0 and $83 for the three months  ended June 30, 2004 and 2003, respectively, and $0 and $167 for the six  months ended June 30, 2004 and 2003, respectively)      |       | 1,001                                |       | 506                                |       | 2,044 |   | 697 |   |
| Depreciation and amortization                                                                                                                                                                                                                     |       | 102                                  |       | 0                                  |       | 204 |   | 0 |   |
| Total costs and expenses from operating  activities from continuing operations                                                                                                                                                                    |       | 2,310                                |       | 1,372                              |       | 4,446 |   | 2,185 |   |
| Loss from operating activities of  continuing operations                                                                                                                                                                                          |       | (2,310                               | )          | (1,372                             | )          | (4,446 | ) | (2,185 | ) |
| Interest and other income                                                                                                                                                                                                                         |       | 13                                   |       | 0                                  |       | 20 |   | 0 |   |
| Change in fair value of warrants and  conversion options                                                                                                                                                                                          |       | 348                                  |       | 0                                  |       | 348 |   | 0 |   |
| Interest and other expense                                                                                                                                                                                                                        |       | (2                                   | )          | 0                                  |       | (3 | ) | 0 |   |
| Loss from continuing operations                                                                                                                                                                                                                   |       | (1,951                               | )          | (1,372                             | )          | (4,081 | ) | (2,185 | ) |
| Income (loss) from discontinued operations                                                                                                                                                                                                        |       | 7                                    |       | (1,627                             | )          | 29 |   | (2,699 | ) |
|                                                                                                                                                                                                                                              |       |                                 |       |                               |       |   |   |   |   |
| Net loss                                                                                                                                                                                                                                          |       | (1,944                               | )          | (2,999                             | )          | (4,052 | ) | (4,884 | ) |
| Accretion on preferred stock and dividends                                                                                                                                                                                                        |       | (31                                  | )          | 0                                  |       | (31 | ) | 0 |   |
| Net loss applicable to common shareholders                                                                                                                                                                                                        |       | $                                    | (1,975     | )                                  | $          | (2,999 | ) | $ | (4,083 | ) | $ | (4,884 | ) |
|                                                                                                                                                                                                                                              |       |                                 |       |                               |       |   |   |   |   |
| Net loss per common share (basic and  diluted)                                                                                                                                                                                                    |       | $                                    | (0.07      | )                                  | $          | (0.13 | ) | $ | (0.15 | ) | $ | (0.21 | ) |
| Weighted average common shares outstanding -  basic and diluted                                                                                                                                                                                   |       | 27,898,268                           |       | 23,579,861                         |       | 27,380,133 |   | 23,579,256 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**WORLDGATE COMMUNICATIONS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(Dollars in Thousands)**

 
| ** **                                                                                       | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                                                       | ** ** | **(As restated)**                   | ** ** | ** ** | ** ** |
| **Cash flows from operating activities of  continuing operations:**                              |       |                                |       |   |   |
| Net loss                                                                                         |       | $                                   | (4,081     | ) | $ | (2,185 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities of continuing operations |       |                                |       |   |   |
| Depreciation and amortization                                                                    |       | 204                                 |       | 0 |   |
| Change in fair value of warrants and  conversion options                                         |       | (348                                | )          | 0 |   |
| Non-cash stock based compensation                                                                |       | 1                                   |       | 0 |   |
| Changes in operating assets and liabilities  from continuing operations:                         |       |                                |       |   |   |
| Accounts receivable                                                                              |       | 28                                  |       | 0 |   |
| Prepaid and other assets                                                                         |       | 247                                 |       | 0 |   |
| Accounts payable                                                                                 |       | (294                                | )          | 357 |   |
| Accrued expenses                                                                                 |       | 477                                 |       | 359 |   |
| Accrued compensation and benefits                                                                |       | 40                                  |       | 521 |   |
| Other                                                                                            |       | 285                                 |       | 0 |   |
| Net cash used in operating activities of  continuing operations                                  |       | (3,441                              | )          | (948 | ) |
| **Cash flows from investing activities of  continuing operations:**                              |       |                                |       |   |   |
| Capital expenditures                                                                             |       | (30                                 | )          | 0 |   |
| Net cash provided by investing activities  of continuing operations                              |       | (30                                 | )          | 0 |   |
| **Cash flows from financing activities of  continuing operations:**                              |       |                                |       |   |   |
| Proceeds from the issuance of common stock                                                       |       | 2,509                               |       | 0 |   |
| Proceeds from the issuance of redeemable  preferred stock                                        |       | 7,111                               |       | 0 |   |
| Proceeds from the exercise of stock options                                                      |       | 126                                 |       | 0 |   |
| Proceeds from the exercise of stock rights  and warrants                                         |       | 620                                 |       | 0 |   |
| Net cash provided by financing activities  of continuing operations                              |       | 10,366                              |       | 0 |   |
| **Net cash contributed to continuing  operations from discontinued operations**                  |       | 46                                  |       | 1,122 |   |
| **Net increase in cash**                                                                         |       | 6,941                               |       | 174 |   |
| **Cash and cash equivalents, beginning of  period**                                              |       | 3,365                               |       | 589 |   |
| **Cash and cash equivalents, end of period**                                                     |       | $                                   | 10,306     |   | $ | 763 |   |
|                                                                                             |       |                                |       |   |   |
| **Cash paid for interest**                                                                       |       | $                                   | 2          |   | $ | 9 |   |
| **Non-cash financing activity:**                                                                 |       |                                |       |   |   |
| Issuance of note payable to finance D&O  insurance                                           |       | $                                   | 256        |   | $ | 560 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(Dollar Amounts are in Thousands, Except forper Share and Share Amounts)

(Unaudited)

 

1.                                       Basisof Presentation.

 

The unaudited financial statements ofWorldGate Communications, Inc. (“WorldGate” or the “Company”) for the three andsix months ended June 30, 2004 presented herein have been prepared by theCompany pursuant to the rules and regulations of the Securities and ExchangeCommission for quarterly reports on Form 10-Q. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to such rules andregulations.  These financial statementsshould be read in conjunction with the financial statements for the year endedDecember 31, 2003 and the notes thereto included in the Company’s Annual Reporton Form 10-K.

 

The financial information in this Reportreflects, in the opinion of management, all adjustments of a normal recurringnature necessary to present fairly the results for the interim period.Quarterly operating results are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2004.

 

2.                                       RestatementNo. 1

 

The Company has restated its financialstatements for the three and six months ended June 30, 2004. In the secondquarter of 2004, the Company incorrectly made accounting entries to record theCompany’s June 23, 2004 private placement of Series A Convertible PreferredStock and Warrants using a “relative fair value” basis of accounting. OnNovember 10, 2004, the Company determined that the proceeds of the privateplacement transaction should be allocated using a “fair value” basis ofaccounting for the warrants and conversion options and should also be marked tomarket as of June 30, 2004, with the residual amount to preferred stock insteadof the “relative fair value” basis. The net effect of these adjustments at June30, 2004 increases the Company’s current liabilities and redeemable preferredstock, and reduces its losses. Certain information provided in Management’sDiscussion and Analysis of Financial Condition and Results of Operations hasbeen revised to reflect these restatements.

 

The effect of the restatement on specificamounts provided in the consolidated financial statements is as follows:

 
| ** **                                                                | ** ** | **As of June 30, 2004**                      | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Consolidated Balance Sheet**                                            | ** ** | **As previously reported**                   | ** ** | **As restated** | ** ** |
|                                                                      |       |                                         |       |   |   |
| Detachable  Warrants                                                      |       | $                                            | 1,390      |   | $ | 1,723 |   |
| Conversion  Option on Preferred Stock                                     |       | 1,840                                        |       | 2,247 |   |
| Beneficial  Conversion Option on Preferred Stock                          |       | 1,714                                        |       | 0 |   |
| Redeemable  Preferred Stock                                               |       | 2,187                                        |       | 2,816 |   |
| Accumulated  deficit                                                      |       | (203,701                                     | )          | (202,026 | ) |
| Total  stockholders’ equity                                          |       | 2,510                                        |       | 2,855 |   |
|                                                                      |       |                                         |       |   |   |
| ** **                                                                | ** ** | **For the three months ended June 30, 2004** | ** ** |
| **Consolidated Statement of  Operations**                                 | ** ** | **As previously reported**                   | ** ** | **As restated** | ** ** |
|                                                                      |       |                                         |       |   |   |
| General and  Administrative expenses                                      |       | $                                            | 1,012      |   | $ | 1,001 |   |
| Total  expenses                                                           |       | 2,321                                        |       | 2,310 |   |
| Loss from  operating activities from continuing operations                |       | (2,321                                       | )          | (2,310 | ) |
| Change in  fair value of warrants and conversion options                  |       | 0                                            |       | 348 |   |
| Loss from  continuing operations                                          |       | (2,310                                       | )          | (1,951 | ) |
| Net loss                                                                  |       | (2,303                                       | )          | (1,944 | ) |
| Accretion on  preferred stock and dividends                               |       | (16                                          | )          | (31 | ) |
| Net loss  applicable to common shareholders                               |       | (2,319                                       | )          | (1,975 | ) |
| Net loss  applicable to common shareholders per share (basic and diluted) |       | $                                            | (0.08      | ) | $ | (0.07 | ) |
|                                                                      |       |                                         |       |   |   |   |   |
| ** **                                                                | ** ** | **For the six months ended June 30, 2004**   | ** ** |
| ** **                                                                | ** ** | **As previously reported**                   | ** ** | **As restated** | ** ** |
|                                                                      |       |                                         |       |   |   |
| General and  Administrative expenses                                      |       | $                                            | 2,685      |   | $ | 2,044 |   |
| Total  expenses                                                           |       | 5,087                                        |       | 4,446 |   |
| Loss from  operating activities from continuing operations                |       | (5,087                                       | )          | (4,446 | ) |
| Change in  fair value of warrants and conversion options                  |       | 0                                            |       | 348 |   |
| Loss from  continuing operations                                          |       | (5,070                                       | )          | (4,081 | ) |
| Net loss                                                                  |       | (5,041                                       | )          | (4,052 | ) |
| Accretion on  preferred stock and dividends                               |       | (16                                          | )          | (31 | ) |
| Net loss  applicable to common shareholders                               |       | (5,057                                       | )          | (4,083 | ) |
| Net loss  applicable to common shareholders per share (basic and diluted) |       | $                                            | (0.18      | ) | $ | (0.15 | ) |

 

3.                                       Restatement No. 2

 

The Company has restated its financial statements for the six monthsended June 30, 2004 to amend and restate the accounting for the warrants andadditional investments rights issued in a private placement of the Company’scommon stock during the fourth quarter of 2003 and the first quarter of2004.  These security components wereoriginally treated as non-cash expenses and with this restatement are beingrestated as equity transactions. There is no cash impact associated with theserestatements. There were also related adjustments to the Company’s consolidatedstatement of cash flows and consolidated statement of stockholders’ equity.

 

The effect of the restatement on specific amounts provided in theconsolidated financial statements is as follows:

 

7

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| ** **                      | ** ** | **As of June 30, 2004**    | ** ** |
|---------------------------------|------------|----------------------------|------------|
| **Consolidated Balance Sheet**  | ** ** | **As previously reported** | ** ** | **As restated** | ** ** |
|                            |       |                       |       |   |   |
| Accumulated deficit             |       | $                          | (203,356   | ) | $ | (202,026 | ) |
| Additional-paid-in capital      |       | 206,329                    |       | 204,999 |   |
| Total stockholders’ equity |       | 2,855                      |       | 2,855 |   |
|                                 |            |                            |            |  |  |  |  |

 
|                                                                 |       |                                       |       |             |       |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **For the six months ended June 30, 2004** | ** ** |
| **Consolidated Statement of Operations**                             | ** ** | **As  previously reported**                | ** ** | **As  restated** | ** ** |
|                                                                 |       |                                       |       |             |       |
| General and Administrative expenses                                  |       | $                                          | 2,674      |             | $          | 2,044 |   |
| Total expenses – operating activities of  continuing operations |       | 5,076                                      |       | 4,446            |       |
| Net loss                                                             |       | (4,682                                     | )          | (4,052           | )          |
| Net loss applicable to common shareholders                           |       | (4,713                                     | )          | (4,083           | )          |
|                                                                 |       |                                       |       |             |       |
| Net loss applicable to common shareholders  per share:               |       |                                       |       |             |       |
| Basic                                                                |       | $                                          | (0.17      | )                | $          | (0.15 | ) |
| Diluted                                                              |       | (0.17                                      | )          | (0.15            | )          |

 

In addition, the Company has included restatements to reflect certainclarifications made in response to the SEC’s comments as raised in its reviewof the Company’s registration statement on Form SB-2 as filed with the SEC onMay 24, 2005, on Form SB-2/A as filed with the SEC on August 30, 2005 and onForm 10KA as filed with the SEC on August 30, 2005. These restatements includeexpanded clarifications on the preferred stock transaction the Companycompleted in June of 2004, liquidity and going concern considerations andchanges to the Notes to Consolidated Financial Statements.

 

4.                                       Liquidity andGoing Concern Considerations.

 

As of June 30, 2004 the Company had cash and cash equivalents of$10,306. The operating cash usage from continuing operations for the three andsix months ended June 30, 2004 was $1,662 and $3,441, respectively.  During the third quarter of 2003, wecompleted a sale of certain assets, including our ITV intellectual propertyrights and our membership interest in TVGateway, LLC, for $3,000 in cash toTVGateway, LLC, a company we were instrumental in forming. Our transaction withTVGateway, LLC, marked a shift in our business away from the ITV business andtoward a new video phone product and associated business.  The funds we received from the sale of assetsto TVGateway, LLC, as well as the funds we received as a result of private

 

8

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placements ofour securities on December 1, 2003, December 4, 2003, January 21, 2004, April22, 2004, and June 23, 2004, have permitted us to fund the development of ournew business.

 

In December 2003 and January 2004, WorldGate received investmentsaggregating to a total of $3,100 by certain institutional investors.  These investors purchased an aggregate of3,000,000 shares of newly issued common stock. The investors also received aright, for a limited period of time, to purchase additional shares of up to 20%of the common stock purchased by the investors in their investment, at the sameprice as their investment, and five-year warrants to purchase up to 30% of thecommon stock purchased by the investors in their investment, at an exerciseprice equal to a twenty-five percent premium to their purchase price for theinvestment.  The purchase price for the 2,000,000shares purchased in December 2003 transactions was $0.80 per share, with thewarrants having a $1.00 per share exercise price.  The purchase price for the 1,000,000 sharespurchased in the January 2004 transaction was $1.50 per share, with thewarrants having a $1.875 per share exercise price.  All additional investment rights associatedwith the December 2003 transaction were exercised during January and Februaryof 2004, resulting in an incremental investment of $320.  All additional investment rights associatedwith the January 2004 transaction were exercised in May 2004, resulting in anincremental investment of $300.

 

InDecember 2003, WorldGate announced that it reached agreement with Mototech,Inc. (not an affiliate of Motorola) for the purchase of 625,000 shares of newly issued common stock at$0.80 per share, in return for future design and engineering services byMototech.  WorldGate previously announcedin November 2003, that it had contracted with Mototech to assist the Companywith the design and volume manufacture of WorldGate’s Ojo personal video phone.As compensation for these shares the Company will receive an equivalentreduction in future development and initial procurement payments that wouldotherwise be due to Mototech.  The valueof this transaction was $600 (based on the closing stock price of $0.96 on thedate of the transaction) of which $200 was recorded as an expense for the yearended December 31, 2003.  The remaining$400 was recorded as unearned compensation in stockholders equity section inthe accompanying balance sheet.  Mototechis an affiliate of Accton Technology Group, a group of Taiwanese manufacturersthat we believe are well-known in the electronics industry.  They currently manufacture and distribute afull range of high performance high speed data and computer networking products,including cable set top boxes, home gateways, wireless LANs, hubs, switches,routers, and other related products.  Inaddition, in April 2004, Mototech invested $1,000 to purchase 666,666 shares ofnewly issued common stock at $1.50 per share.

 

In June 2004, WorldGatecompleted a private placement of 7,550 shares of its Preferred Stock at astated value of $1000 per share, which preferred stock is convertible into theCompany’s common stock at a conversion price of $2.35 per share; five-yearwarrants to purchase up to 803,190 shares of our common stock at an exerciseprice of $2.69 per share; and five-year warrants to purchase up to 803,190shares of our common stock at an exercise price of $3.14 per share. Theinvestors also received an additional investment right, for a limited period oftime, to purchase 1,606,383 additional shares of common stock shares at $3.14 ashare.

 

The Company has $6,179 of liabilities and its assets are not pledged ascollateral as of June 30, 2004. The Company continues to evaluate possibilitiesto obtain additional financing through public or private equity or debtofferings, bank debt financing, asset securitizations, or from othersources.  Such additional financing wouldbe subject to the risk of availability, may be dilutive to our shareholders, orcould impose restrictions on operating activities. There can be no assurancethat this additional financing will be available on terms acceptable to theCompany, if at all. The Company has limited capacity to further reduce itsworkforce and scale back on capital and operational expenditures to decreaseits cash usage given the measures it has already taken to reduce staff andexpenses.

 

Our Company has sufferedrecurring losses from operations and had a net accumulated deficiency of$198,000 as of December 31, 2003, and these issues raise substantial doubtabout our Company’s ability to continue as a going concern. Our short term cashrequirements and obligations include inventory, accounts payable and capitalexpenditures from continuing operations, operating expenses, and leasecommitments. We expect, based on our internal forecasts and assumptionsrelating to our operations (including among others, assumptions regarding ourshort term cash requirements and our projected revenue growth ) that we havesufficient cash on hand to meet our obligations for at least the next twelvemonths.

 

Our ability to generate cashis dependant upon the sale of our Ojo product and on obtaining cash throughcapital markets.  We have not generatedany revenue from commercial shipments of our Ojo product and we do know when orif we will. Given that our video phone business involves the development of anew product line with no market penetration, in an undeveloped market sector,no assurances can be given that sufficient sales, if any, will materialize.

 

Additionally, as needed, weplan to generate cash by turning to the capital markets for funding.  Although we raised an additional $7,550 infinancing in June 2004, no assurances can be given that, if pursued, additionalfinancing transactions can be consummated. We continue to evaluate possibilities to obtain additional financingthrough public or private equity or debt offerings, bank debt financing, assetsecuritizations, or from other sources, should we need to obtain suchfinancing.  Such additional financingwould be subject to the risk of availability, may be dilutive to ourshareholders, or could impose restrictions on operating activities. There canbe no assurance that this additional financing will be available on termsacceptable to us, if at all.

 

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We, however, remain hopefulthat sufficient sales will materialize and/or that sufficient funding can bedeveloped through ongoing operations or additional financings to continue ouroperations beyond the next twelve months.

 

Our long term cashrequirement obligations are primarily comprised of the items noted above. Wehave no long term debt and our contractual cash requirements and obligationsexisting beyond the next twelve months are comprised solely of the operatinglease commitments described above.  Wehave limited capacity to further reduce our workforce and scale back on capitaland operational expenditures to decrease our cash usage.

 

5.                                       RecentAccounting Pronouncement.

 

InJanuary 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities*. InterpretationNo. 46 addresses consolidation by business enterprises of variable interestentities, which are entities that either (a) do not have equity investors withvesting rights or (b) have equity investors that do not provide sufficientfinancial resources for the entity to support its activities. Theinterpretation is effective immediately for variable interest entities createdafter February 1, 2003. In December 2003, the FASB published FASBInterpretation No. 46 (revised December 2003), *Consolidationof Variable Interest Entities* (FIN 46(R)). FIN 46(R), among otherthings, defers the effective date of implementation for certain entities. Therevised interpretation is effective for the first interim or annual reportingperiod ending after March 15, 2004, with the exception of structures that arecommonly referred to as special-purpose entities, for which the statement iseffective for periods ending after December 15, 2003. The adoption ofInterpretation No. 46 did not have a material impact on WorldGate’s results ofoperations or financial position.

 

InMay 2003, the FASB issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. SFAS No. 150 establishes standards for classification andmeasurement by an issuer of certain financial instruments with characteristicsof both liabilities and equity. The statement requires that an issuer classifya financial instrument that is within the scope as a liability (or asset insome circumstances). This statement is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003, except asit relates to consolidated limited-life subsidiaries. The FASB indefinitelydeferred the effective date of this statement as it relates to certainmandatorily redeemable non-controlling interests in consolidated limited-lifesubsidiaries. WorldGate does not have any interest in limited-life entities asof June 30, 2004. The adoption of the effective provisions of SFAS No. 150 didnot have an impact on WorldGate’s results of operations or financial position.

 

6.                                       Inventories.

 

Inventories are summarized as follows:

 
| ** **                                   | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                         |       |              |       |                  |       |
| Raw material  (from discontinued operations) |       | $                 | 1,622      |                  | $          | 1,622 |   |
| Work in  progress                            |       | —            |       | —                |       |
| Finished  goods                              |       | —            |       | —                |       |
| Inventory  held by customers and vendors     |       | —            |       | —                |       |
| Total  inventory                             |       | 1,622             |       | 1,622                 |       |
| Inventory  reserve                           |       | (1,622            | )          | (1,622                | )          |
| Inventory,  net                              |       | $                 | —     |                  | $          | — |   |

 

7.                                       Accounting forPreferred Shares and Derivative Shares (Restated)

 

Thefollowing information has been restated to provide a more complete descriptionof the accounting method and policy related to redeemable preferred shares andderivative shares.

 

InJune 2004, WorldGate completed a private placement of Preferred Stock. ThePreferred Stock has a dividend rate of 5% per annum, payable quarterly, eitherby cash or through the issuance of common stock at the Company’s option. ThePreferred Stock has a staged maturity over three years with one-third of thePreferred Stock to be redeemed after 18 months, one-third after 24 months andone-third after 36 months, and may be redeemed at maturity in cash or, at theCompany’s option, subject to certain conditions that may not be solely underthe control of the Company, through the issuance of the number of shares ofcommon stock determined by dividing the liquidation preference of the preferredshares by the then current market price. If the effectiveness of the registration statement lapses, the Companyceases to be listed on certain specified exchanges and trading in the Company’sstock is suspended or a change in control occurs with respect to the Company,the Company may be required to settle redemption of the preferred stock withcash instead of its common shares. Furthermore, since the market price of the Company’s common stock cannotbe predicted, the actual number of shares of the Company’s common stock thatwill be required if a redemption is made through the issuance of common stock,can also not be predicted.

 

ThePreferred Stock has embedded conversion options. Specifically, the holders ofthe Preferred Stock may convert their shares into the Company’s common stock ata conversion price of $2.35 per share. In addition the Company may forceconversion of

 

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the Preferred Stock intocommon stock if the Company achieves certain price targets for its common stockand satisfaction of certain other conditions, such as the existence of aneffective registration statement. In either event the conversion price issubject to adjustment if, at any time after the date the preferred shares wereissued, the Company issues or sells, or is deemed to have issued or sold, anyshares of the Company’s common stock for per share consideration less than theconversion price of the preferred shares on the date of such issuance orsale.  Accordingly, the number of commonshares issuable upon the conversion of the preferred shares cannot bepredicted.  Furthermore, net-cashsettlement may be required in the event of conversion default under certaincircumstances that may not be solely under the control of the Company.  If the effectiveness of the registrationstatement lapses, the Company ceases to be listed on certain specifiedexchanges and trading in the Company’s stock is suspended or a change incontrol occurs with respect to the Company, the Company may be required tosettle a conversion of the preferred stock with cash instead of its commonshares.

 

Also as part of the privateplacement, the Company issued five-year warrants to purchase up to 803,190shares of our common stock at an exercise price of $2.69 per share andfive-year warrants to purchase up to 803,190 shares of our common stock at anexercise price of $3.14 per share. The investors also received an additionalinvestment right, for a limited period of time, to purchase 1,606,383additional shares of common stock shares at $3.14 a share. This exercise priceof the warrants is subject to adjustment if, at any time after the date thewarrants were issued, the Company issues or sells, or is deemed to have issuedor sold, any shares of the Company’s common stock for per share considerationless than the exercise price of the warrants on the date of such issuance orsale.  Accordingly, the number of commonshares that will be issued upon the exercise of the warrants cannot bepredicted.  As of June 30, 2004, none ofthe warrants and none of the additional investment rights had been exercised.

 

Ofthe 7,550 preferred shares issued under this private placement, there were noshares redeemed as of June 30, 2004.

 

Withrespect to the Company’s accounting for the Preferred Stock, EITF Topic D-98,paragraph 4, states that Rule 5-02.28 of Regulation S-X requires securitieswith redemption features that are not solely within the control of the issuerto be recorded outside of permanent equity. As described above, the terms ofthe Preferred Stock include certain redemption features that may be triggeredby events that are not solely within the control of the Company, such as apotential failure in the Company’s ability to maintain an effectiveregistration statement. Furthermore, the actual number of shares of commonstock required to satisfy redemption is based upon the market value of thecommon stock at the time of the redemption, which cannot be predicted.Accordingly, the Company has classified the Preferred Stock as temporary equityand the value ascribed to the redeemable preferred stock upon initial issuance,i.e. at June 23, 2004, was the amount received in the transaction minus thefair value ascribed to the conversion options and warrants. The initial valueof the redeemable preferred stock is accreted up to the redemption value (theamount received in the transaction) over the future relevant periods using theinterest method. .The value ofthe redeemable preferred stock at June 30, 2004 was $2,816.

 

Theterms of the Preferred Stock include certain conversion options that representderivative financial instruments under paragraph 12 of SFAS No. 133 and thuswere separated from the Preferred Stock and valued using the Black-Scholesoption pricing model.  The conversionoptions include certain provisions that could result in a variable number ofshares to be issued upon conversion, adjustment to the strike price at whichconversion shares will be determined, or the requirement for the Company tosettle the conversion options in cash EITF 00-19, “Accounting for DerivativeInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock”,state that if the conversion options require net cash settlement in the event ofcircumstances that are not solely within the Company’s control they should beclassified as a liability measured at fair value on the balance sheet.

 

Theterms of the five-year warrants include cash penalty provisions in the eventthat the Company fails to meet its obligations to deliver registered shares tothe warrant holder upon exercise and an anti-dilution provision that couldresult in a variable number of shares to be issued upon warrant exercise.Additionally, the terms and conditions of the warrants provide for netsettlement via cashless exercise whereby the shares delivered to the warrantholder would be readily convertible to cash. In accordance with EITF 00-19 andgiven the terms and conditions of the warrants as outlined above, the Company hasclassified the warrants as a liability on its balance sheet measured at fairvalue using the Black-Scholes option pricing model.

 

TheCompany accounts for both the conversion options and warrants using the fairvalue method at the end of each quarter, with the resultant gain or lossrecognition recorded against earnings. Both the warrants and conversion optionsare valued using the Black-Scholes valuation model. Actual period close commonstock prices, applicable volatility rates, and the period close risk-freeinterest rate for the instrument’s expected remaining life (continuouslycompounded), are the key assumptions used in the valuation calculation. TheWorldGate share price changed from $2.20 per share as of June 23, 2004 to $2.10per share at June 30, 2004 making the warrants and preferred stock conversionelements less valuable, and therefore less costly, relative to their strikeprice. The result was a $348 non cash gain for the quarter ended June 30, 2004.

 

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8.                                       Stock-BasedCompensation (as restated).

 

The Company accounts for stock-basedcompensation in accordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations.

 

The Company applies Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations in accounting for its plans, and accordingly, no compensationcost has been recognized for the Company’s fixed stock based compensation. Hadcompensation cost been determined consistent with SFAS No. 123, as amended bySFAS No. 148, the Company’s net loss would have been increased to the followingpro forma amounts:

 
| ** **                                                                                                                           | ** ** | **For the Three Month Period  Ended June 30,** | ** ** | **For the Six Month Period  Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                            | ** ** | **2003**                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                           | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| Net loss:                                                                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                                   | (1,944     | )                                                 | $          | (2,999 | ) | $ | (4,052 | ) | $ | (4,884 | ) |
| Add: Stock-based compensation expense  included in reported net loss, net of related tax effects of $0                               |       | 0                                                   |       | 0                                                 |       | 0 |   | 40 |   |
| Deduct: Total stock-based employee expense  determined under the fair value based method for all awards, net of related  tax effects |       | (520                                                | )          | (1,350                                            | )          | (1,083 | ) | (2,770 | ) |
| Pro forma net loss                                                                                                                   |       | $                                                   | (2,464     | )                                                 | $          | (4,349 | ) | $ | (5,135 | ) | $ | (7,614 | ) |
|                                                                                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Net Loss per share:                                                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Basic and diluted— as reported                                                                                                  |       | $                                                   | (0.07      | )                                                 | $          | (0.13 | ) | $ | (0.15 | ) | $ | (0.21 | ) |
| Basic and diluted - pro forma                                                                                                        |       | $                                                   | (0.09      | )                                                 | $          | (0.18 | ) | $ | (0.19 | ) | $ | (0.32 | ) |

 

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Such pro forma disclosures maynot be representative of future compensation expense because options vestover several years and additional grants are made each year.

 

9.                                       SignificantAgreements and Transactions.

 

In 1997, the Company entered into agreementswith certain cable operators who are investors. Revenues recognized from such investors were approximately $0 and $65,respectively, for the three months ended June 30, 2004 and 2003, andapproximately $0 and $136, respectively, for the six months ended June 30, 2004and 2003. Accounts receivable from such investors amounted to approximately $0at June 30, 2004 and $2 at December 31, 2003.

 

The Company has a current two year agreementwith an investor, and previously had agreements with certain other investors,to provide engineering and development support. As a result of thoseagreements, the Company has expensed approximately $0 and $165, respectively,for the three months ended June 30, 2004 and 2003, and approximately $0 and$556, respectively, for the six months ended June 30, 2004 and 2003. Accountspayable to these stockholders amounted to $528 and $170 at June 30, 2004 andDecember 31, 2003, respectively. Some of these stockholders were suppliers oftechnology and components for the Company’s discontinued ITV products andservices. These agreements provided for licensing of technology, as well ascontracted services, including hardware and software development, producttesting and certification, and the creation and development of tools andsystems to facilitate the Company’s engineering efforts. These agreements didnot provide for ongoing royalties, purchase provisions, or for any requirementto provide additional funding to the Company.

 

OnApril 28, 2004, we entered into a Development and Distribution Agreementwith General Instrument Corporation d/b/a the Broadband Communication Sector ofMotorola, Inc., or Motorola. In connection with the Development andDistribution Agreement with Motorola, we issued a warrant to Motorola topurchase 300,000 shares of our common stock at an exercise price of $1.4375 pershare, and agreed to issue additional warrants to purchase up to an additional1,950,000 shares of our common stock, upon the achievement of certain productand sales milestones, at an exercise price based upon the average closing salesprice of our common stock during the 20 day period preceding the issuanceof each warrant.

 

In 1998 theCompany entered into a leasing arrangement for a building with an entity formedby non-employee investors. Included in deposits and other assets at June 30,2004 and December 31, 2003 is $0 and $388, respectively, related to this lease.We have not paid our rent on our current facility since May 2003. As a result,our landlord, 3190 T General, Inc. in September 2003, filed an action in theCourt of Common Pleas, Bucks County Pennsylvania to perfect its interest totake possession of our facility at anytime, and to establish damages for pastrent and expenses. In lieu of rent payments our landlord has drawn from oursecurity deposit to satisfy the unpaid rent and such deposit has now been fullydepleted. A judgment was also granted allowing our landlord to regainpossession of the facility, although we remain in the facility, albeit insubstantially reduced space. During this process we attempted to negotiate asettlement of our lease obligation with the landlord in an effort to reduce ouroutstanding liability and secure the continued right to occupy the facilitywith a reduced ongoing lease obligation. We also worked with the landlord tosecure other tenants for the unused space. However, we were informed by thelandlord that this process was complicated by the requirement for the landlord’smortgage holder to approve any such amendments to our lease as well as anyarrangements with other prospective tenants. The landlord was not able toobtain such approvals from the mortgage holder and ultimately the landlord andthe landlord’s mortgage holder reached an agreement for the landlord’s mortgageholder to become a successor to the landlord’s interest in the property. Wehave already commenced negotiations directly with the mortgage holder’srepresentatives to secure the continued right to occupy the facility with areduced ongoing lease obligation, and are currently awaiting a proposal fromthe mortgage holder, although there can be no assurance that an agreement canbe reached with the mortgage holder. Concurrently we are exploring otherfacility opportunities in the event an agreement cannot be reached. In lieu ofmonthly rent payments of $104 (offset by monthly sublease payments by TVGatewayof $19 during the period February 1, 2003 through January 31, 2004), theCompany’s landlord has drawn down from its security deposit to satisfy $750 ofthe unpaid rent of $1,223 as of June 30, 2004. As of June 30, 2004, the amountof the deposit remaining after deduction for the unpaid rent is $0.  The Company has continued to accrue the fullrent expense through June 30, 2004.

 

10.                                 TVGateway JointVenture and related Cable Operator Agreements.

 

On July 24, 2000, the Company formed a separate joint venture,TVGateway, LLC, with four cable operators. As part of this venture WorldGate entered into a management agreementwith TVGateway to provide engineering, operations and administrative supportservices. In addition to providing for the terms and conditions under whichsuch services were to be provided, the management agreement provided forWorldGate and TVGateway to cooperate to transition to TVGateway some or all ofthe support services being provided by WorldGate and/or the employees providingthese services. In addition, this provision required WorldGate to remainavailable to provide support services until July 24, 2005. During 2002WorldGate and TVGateway agreed to

 

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commence the transition of services pursuant to this provision. Inaddition, the parties agreed that the management agreement would be of nofurther force and effect with respect to the services that are transferred asof the date of completion of the specific transfers. The companies completedthis transition in the first quarter 2003, and accordingly, WorldGate has nowbeen relieved of any continuing obligation to provide such transitionedservices.  Further, WorldGate will nolonger receive future revenues from the management agreement with TVGateway.

 

Revenues for such services, which are included in service fee revenue,totaled $0, and $732 (included in discontinued operations), respectively forthe three months ended June 30, 2004 and 2003, and $0 and $788 (included indiscontinued operations), respectively, for the six months ended June 30, 2004and 2003. In addition, product sales to TVGateway totaled $0 and $0 for thethree months ended June 30, 2004 and 2003, respectively, and $0 and $1,079(included in discontinued operations), respectively, for the six months endedJune 30, 2004 and 2003. Accounts Receivable from TVGateway amounted to $0 atJune 30, 2004 and $0 at December 31, 2003. WorldGate was accounting forits 18% investment in the TVGateway joint venture, which was previously reducedto a carrying value of $0 due to prior losses, under the equity method.

 

On September30, 2003 the Company announced that it had sold to TVGateway, LLC certain ITVintellectual property rights and certain software and equipment related to theITV business, which TVGateway was currently using, for $2,400.  In addition, on August 7, 2003, WorldGate andTVGateway entered into a redemption agreement pursuant to which TVGatewayredeemed WorldGate’s equity interest in TVGateway for $600 in cash.  The purchase price for these assets in theaggregate was $3,000 and was used by the Company to fund continuing operations,as well as to develop and distribute its new Ojo video telephony product. Aspart of this transaction WorldGate retained a royalty-free license to certainof the transferred intellectual property rights and software. At this time theCompany has completely exited from the interactive television (ITV) business.

 

In connectionwith the Asset Purchase Agreement we entered into with TVGateway for the saleof certain ITV Business assets, we have an obligation to indemnify TVGatewayfor any losses from breaches of our representations or warranties in the AssetPurchase Agreement that occur within twelve months after the closing date ofthe TVGateway transaction or within the applicable statute of limitationsperiod for claims relating to our ownership of our assets, payment of ourtaxes, and our compliance with applicable laws, if longer. Our indemnificationobligations are limited by an overall cap of $500 on the amount of theindemnification. Although we know of no breaches of our representations orwarranties, the payment of any such indemnification obligations would adverselyimpact our cash resources and our ability to pursue our video phone business.

 

11.                                 Net Loss per Share.

 

Basic and diluted net loss per common shareis computed by dividing the net loss available to common stockholders for theperiod by the weighted average number of shares of common stock outstandingduring the period.  The calculation ofdiluted net loss per common share excludes potential common shares if theeffect is antidilutive.  Potential commonshares comprise shares of common stock issuable upon the exercise of stock optionsand warrants.  The number of potentialcommon shares which would have been assumed to be converted in the periodsended June 30, 2004 and 2003 and have a dilutive effect if the Company hadincome from continuing operations, or if the options’ exercise price was lessthan the average market price of the common shares, is 12,968,818 and5,932,513, respectively.

 

12.                                 Risksand uncertainties

 

Our primaryline of business is the development of video phone products and technology. Weare still in the process of launching our first product based on thistechnology and, although we have realized some revenues for the commercial saleof our product, the revenues to date have not been substantial. Given the earlystage of our product and the lack of operating history in the video phonebusiness, it is difficult to predict our future results.

 

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We haveentered into a six year distribution agreement with Motorola, Inc. for themarketing and distribution of our Ojo video phone. This agreement provides forMotorola to be WorldGate’s exclusive distributor of its broadband video phoneproducts and for WorldGate to be Motorola’s exclusive supplier of its broadbandvideo phone products.  Although theagreement requires Motorola to provide for certain marketing and promotionalactivities for the Ojo video phone, there are no required sales quotas for theagreement to remain in effect, and Motorola controls the volume of theCompany’s products being distributed. Neither party can terminate the agreement except in cases of uncuredbreaches of the agreement or as a result of insolvency events suffered by theother party. After a period of 18 months following the commercial availabilityof the Ojo video phone the mutual exclusivity will terminate unless Motorolaelects to continue the mutual exclusivity after having achieved certain minimumsales targets for the Ojo video phone. Motorola may, however, at its option,elect to terminate the exclusivity at any time. In the event mutual exclusivity terminates or is terminated, then for aperiod of twelve months thereafter, WorldGate will continue to be Motorola’sexclusive supplier of broadband video phones but will be free to sell videophones to customers other than certain defined Motorola accounts. During thistwelve month period, Motorola has a right of first refusal to accept and fillany orders for video phone products that WorldGate obtains from non-Motorolaaccounts, and is obligated to use good faith efforts to solicit and acceptproduct orders from Motorola accounts in a commercially reasonable manner.During any period of exclusivity under this agreement we are reliant uponMotorola and its distribution partners, including, for example, wholesalers,retailers and service providers, to provide the worldwide sales anddistribution of the Ojo video phone. If Motorola and its partners are notsuccessful, or if their activities do not lead to significant sales of ourproduct, our operating results will be adversely affected, our revenue could besignificantly reduced and we could lose potential customers.

 

We also dependon relationships with third parties such as contract manufacturing companies,chip design companies and others who may be sole source providers of keycomponents and services critical for the product we are developing in our videophone business. A formal relationship with Mototech, Inc. (not an affiliate of Motorola)has been established for the volume manufacture of Ojo. Mototech is currentlythe sole volume manufacturer of Ojo. Our agreement with Mototech allows eitherparty to terminate the agreement with 90 days prior notice.  If Mototech, Inc. or other providers ofcomponents and/or manufacturing services do not produce these components orprovide their services on a timely basis, if the components or services do notmeet our specifications and quality control standards, or if the components orservices are otherwise flawed, we may have to delay product delivery, or recallor replace unacceptable products. In addition, such failures could damage ourreputation and could adversely affect our operating results. As a result, wecould lose potential customers and any revenues that we may have at that timemay decline dramatically.

 

# ITEM2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

(Dollar Amounts are in Thousands, Except perShare Amounts)

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS.

 

The Company may from time to time makewritten or oral forward-looking statements, including those contained in thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations. The words “estimate,” “project,” “believe,” “intend,” “expect,”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifying words. Inorder to take advantage of the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995, we are hereby identifying certainimportant factors, which could cause our actual results, performance orachievement to differ materially from those that may be contained in or impliedby any forward-looking statement

 

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made by or on behalf of WorldGate.  The factors, individually or in the aggregate,that could cause such forward-looking statements not to be realized include,without limitation, the following: (1) difficulty or inability to raiseadditional financing on terms acceptable to us, (2) difficulty in developingand implementing marketing and business plans, (3) continued losses, (4)industry competition factors and other uncertainty that a market for ourproducts will develop, (5) challenges associated with broadband operators(including, uncertainty that they will offer our products, inability to predictthe manner in which they will market and price our products and existence ofpotential conflicts of interests and contractual limitations impeding theirability to offer our products), (6) departure of one or more key persons, (7)delisting of our Common Stock from the NASDAQ Small Cap Market, (8) changes inregulatory requirements, and (9) other risks identified in our filings with theSecurities and Exchange Commission.  Wecaution you that the foregoing list of important factors is not intended to be,and is not, exhaustive.  We do notundertake to update any forward-looking statement that may be made from time totime by or on behalf of WorldGate.

 

Results of Operations:

 

General

 

Our ITV business hashistorically accounted for substantially all of our revenue.  In the third quarter of 2003, we completed asale of significant assets, including our ITV intellectual property rights andour membership interest in TVGateway, LLC. This transaction marked a shift in our business away from the ITVbusiness and toward a new video phone product and related business.  Although we continued to support ourremaining ITV business into the first quarter of 2004, the development of ourvideo phone product has become a primary business focus.

 

Our video phone business hasnot produced revenues to date.  Theextent and timing of future revenues for our business depends on severalfactors, including our ability to develop our video phone product, the rate ofmarket acceptance of our products and the degree of competition from similarproducts.  We cannot predict to whatextent our video phone product will produce revenues, or when, or if, we willreach profitability.

 

Critical Accounting Policies and Estimates.

 

The consolidated financial statements areprepared in conformity with accounting principles generally accepted in theUnited States.  The preparation of thesefinancial statements required management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

The significant accounting policies of theCompany are described in the notes to the consolidated financial statementsincluded in the annual report on Form 10-K. Judgments and estimates of uncertainties are required in applying theCompany’s accounting policies in many areas. Following are some of the areas requiring significant judgments andestimates:  revenue recognition, accountsreceivable, inventories, and cash flow and valuation assumptions in performingasset impairment tests of long-lived assets.

 

Discontinued Operations

 

During the first quarter of 2004 the Companytransitioned from the business of developing and selling interactivetelevision, or ITV, technology, products and services for use in conjunctionwith cable TV broadband networks (the “ITV business”) to the development of ourvideo phone products as our primary business focus. During the three monthsended June 30, 2004 the Company had revenues from discontinued operations of$7, compared to revenues of $391 for the three months ended June 30, 2003. Forthe six months ended June 30, 2004 and 2003, respectively, revenues were $89and $2,556 respectively. This reduction reflects service revenues of $7 and$342, respectively, for the three months ended June 30, 2004 and 2003, and for thesix months ended June 30, 2004 and 2003, service revenues were $7 and $1,320respectively. Equipment revenues were $0 and $49 for the three months endedJune 30, 2004 and 2003, respectively, and $82 and $1,236, respectively, for thesix months ended June 30, 2004 and 2003. Concurrently, operating expenses,consisting of Research and Development, Marketing and General andAdministration costs were also reduced as a result of the transition from theITV business.  These expenses were $0 forthe three months ended June 30, 2004, compared to $755 for the three monthsended June 30, 2003, and $16 and $2,561, respectively, for the six months endedJune 30, 2004 and 2003.

 

The information in our quarter to quartercomparisons below represents only our results from continuing operations.

 

Three and Six Months Ended June 30, 2004 andJune 30, 2003 (Restated)

 

Revenues.

 

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Revenues. There were no revenues from continuing operations during the three andsix months ended June 30, 2004 and June 30, 2003. We expect that revenues fromvideo phones will not be realized until, at the earliest, the fourth quarter of2004.

 

Costs and Expenses.

 

Cost of Revenues.  There were no costs of revenues fromcontinuing operations during the three and six months ended June 30, 2004 andJune 30, 2003. We expect that costs of revenues from video phones will not beincurred until, at the earliest, the fourth quarter of 2004.

 

Engineering and Development.  Engineering and development expensesprimarily consist of compensation, and the cost of design, programming,testing, documentation and support of the Company’s video phone product.  Engineering and development costs were $799for the three months ended June 30, 2004, compared with $727 for the threemonths ended June 30, 2003. For the six months ended June 30, 2004 and June 30,2003, engineering and development expenses were $1,599 and $1,263,respectively. These increases of $72 and $336, respectively, or 10% and 27%,respectively, for the three and six months ended June 30, 2004, reflect theCompany’s increased concentration of its engineering staff, and related costs,for the further and continuing development of its video phone product.

 

Sales and Marketing.  Sales and marketing expenses consistprimarily of compensation, attendance at conferences and trade shows, travelcosts, promotions and other marketing programs related to the introduction ofthe Company’s video phone product.  Salesand marketing costs were $408 for the three months ended June 30, 2004,compared with $139 for the three months ended June 30, 2003. For the six monthsended June 30, 2004 and 2003, sales and marketing expenses were $599 and $225,respectively. These increases of $269 and $374, respectively, or 193% and 166%,respectively, for the three and six months ended June 30, 2004, reflect theincreased marketing and promotional expenditures, primarily related to tradeshows attendance, for the Company’s video phone product.

 

General and Administrative-as restated.  General and administrative expenses consistprimarily of expenditures for administration, office and facility operations,finance and general management activities, including legal, accounting andprofessional fees.  General andadministrative expenses were $1,001 for the three months ended June 30, 2004,compared with $506 for the three months ended June 30, 2003. For the six monthsended June 30, 2004 and 2003, general and administrative expenses were $2,044and $697, respectively. The increases of $495 and $1,347, respectively, or 98%and 193%, respectively, for the three and six months ended June 30, 2004, areattributable primarily to the Company’s transition of nearly all of itsadministrative management compensation, facility, legal, finance and professionalconsulting fees toward the further development of the video phonebusiness.  For the three and six monthsended June 30, 2003, video phone related costs were 60% and 39%, respectively,of total General and Administrative expense of $845 and $1,807, respectively.

 

Interest and Other Income and InterestExpense.  Interest and other income andinterest expense consist of interest earned on cash and cash equivalents,interest expense on short-term debt and change in fair value of warrants andconversion options.  Interest and otherincome increased from $12 for the three months ended June 30, 2003 to $361 forthe three months ended June 30, 2004, and increased from $39 for the six monthsended June 30, 2003 to $368 for the six months ended June 30, 2004. Primarily,these increases reflect for the three and six months ended June 30, 2004 areported non-cash change in fair value of warrants and conversion options of$348 that resulted from a marked to market adjustment as of June 30, 2004related to the Company’s June 23, 2004 private placement of its Preferred Stockand Warrants.  During the three and sixmonths ended June 30, 2003, the Company earned interest on average cashbalances of approximately $8,963 and $10,913, respectively, and incurredinterest expense related to its insurance financing.  In comparison, during the three and sixmonths ended June 30, 2004 the Company earned interest on average cash balancesof approximately $3,878 and $4,817, respectively, and incurred interest expenserelated to its insurance financing.

 

Income Taxes.  TheCompany has incurred net operating losses since inception and accordingly hadno income taxes and has not recorded any income tax benefit for those losses.

 

Liquidity and Capital Resources.

 

As of June 30, 2004, our primary source ofliquidity consisted of cash and cash equivalents that are highly liquid, are ofhigh quality investment grade and have maturities of less than one year.

 

At June 30, 2004, we had cash and cashequivalents of $10,306 (and no short-term investments) as compared to cash andequivalents of $3,365 (and no short-term investments) at December 31,2003.  Net cash

 

17

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used in continuing operations was $3,441 forthe six months ended June 30, 2004, as compared to $2,813 (included indiscontinued operations) used for the same period in 2003. This increase in netcash used for continuing operations was primarily attributable to the Company’sincrease in expenditures related to the video phone business.  The Company recorded bad debt expense in theamount of $16 from discontinued operations during the six months ended June 30,2004 to reflect its current assessment of the collectability of certainreceivables.

 

Cash provided by investing activities fromcontinuing operations during the three months ended June 30, 2004, totaled$10,366 compared to $0 provided during the same period in 2003.  During the six months ended June 30, 2004 netproceeds from our maturing short-term investments were $0 compared to $3,218(included in discontinued operations) for the six months ended June 30,2003.  Capital expenditures were $30 and$0 for the six months ended June 30, 2004 and 2003, respectively.  During the third quarter of 2003, wecompleted a sale of certain assets, including our ITV intellectual propertyrights and our membership interest in TVGateway, LLC, for $3,000 in cash toTVGateway, LLC, a company we were instrumental in forming.

 

Operations and Liquidity.

 

To date, the Company has funded operations primarilythrough private sales of equity securities and through an initial publicoffering of common stock in April 1999. As of June 30, 2004 the Company had cash, and cash equivalents of$10,306. The operating cash usage from continuing operations for the six monthsended June 30, 2004 was $3,441. As of June 30, 2004 we have $256 of outstandingdebt and our assets are not pledged as collateral.  However, we have not paid our monthly rent of$104 (offset by monthly sublease payments by TVGateway of $19 during the periodFebruary 1, 2003 through January 31, 2004) on our current facility since May2003.  As a result, our landlord, anon-employee investor, has perfected its interest to take possession of ourfacility at any time and has drawn down from our rent deposit to satisfy $750of the unpaid rent of $1,223 as of June 30, 2004.  As of June 30, 2004 the amount of the depositremaining is $0 after deduction for the unpaid rent.  The Company has continued to accrue the fullrent expense through June 30, 2004.  Wecontinue to negotiate to resolve this matter (refer to Part II, Item I LegalProceedings).  Although we are presentlynot seeking additional funding we continue to explore and evaluatepossibilities to obtain additional financing through public or private equityor debt offerings, bank debt financing, asset securitizations, or from othersources.  Such additional financing wouldbe subject to the risk of availability, may be dilutive to our shareholders, orcould impose restrictions on operating activities.  There can be no assurance that thisadditional financing will be available on terms acceptable to us, if atall.  The Company has limited capacity tofurther reduce its workforce and scale back on capital and operationalexpenditures to decrease cash burn given the measures it has already taken toreduce staff and expenses.

 

With the private placement of the Company’s common stock inJanuary 2004, which provided proceeds of $1,500, the private placement of theCompany’s common stock in April 2004 providing proceeds of $1,000, and the June2004 private placement of the Company’s redeemable preferred stock providingproceeds to the Company of $7,550, the Company projects it will have sufficientfunding to continue operations into the third quarter of 2005, assuming noadditional funding is received and assuming no impact from sales. Depending onthe timing and magnitude of the ramp up of video phone sales, we expect thatour current cash may be sufficient to get the company to a cash breakevenposition.  No assurances can be giventhat sufficient sales, if any, will materialize, or that a funding transactioncan be consummated prior to the depletion of our available cash.  We however remain hopeful that sufficientfunding can be developed through funding or ongoing operations to continue theCompany’s operations.

 

The report of theindependent registered public accounting firm for the year ended December 31,2003 included an explanatory paragraph stating that our Company had sufferedrecurring losses from operations and had a net accumulated deficiency of$198,000, and that these issues raised substantial doubt about our Company’sability to continue as a going concern. Our short term cash requirements andobligations include inventory, accounts payable and capital expenditures fromcontinuing operations, operating expenses, lease commitments. We expect, basedon our internal forecasts and assumptions relating to our operations (includingamong others, assumptions regarding our short term cash requirements and ourprojected revenue growth ) that we have sufficient cash on hand to meet ourobligations for at least the next twelve months.

 

Our ability to generate cashis dependant upon the sale of our Ojo product and on obtaining cash throughcapital markets.  We have not generatedany revenue from commercial shipments of our Ojo product and we do not knowwhen or if we will. Given that our video phone business involves thedevelopment of a new product line with no market penetration, in an undevelopedmarket sector, no assurances can be given that sufficient sales, if any, willmaterialize.

 

Additionally, as needed, weplan to generate cash by turning to the capital markets for funding.  Although we raised an additional $7,550 infinancing in June 2004, no assurances can be given that, if pursued, additionalfinancing transactions can be consummated. We continue to evaluate possibilities to obtain additional financingthrough public or private equity or debt offerings, bank debt financing, assetsecuritizations, or from other sources, should we need to obtain suchfinancing.  Such additional financingwould be subject to the risk of availability, may be dilutive to ourshareholders, or could impose restrictions on operating activities. There canbe no assurance that this additional financing will be available on termsacceptable to us, if at all.

 

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We, however, remain hopefulthat sufficient sales will materialize and/or that sufficient funding can bedeveloped through ongoing operations or additional financings to continue ouroperations beyond the next twelve months.

 

Our long term cashrequirement obligations are primarily comprised of the items noted above. Wehave no long term debt and our contractual cash requirements and obligationsexisting beyond the next twelve months are comprised solely of the operatinglease commitments described above.  Wehave limited capacity to further reduce our workforce and scale back on capitaland operational expenditures to decrease our cash usage.

 

In December 2003, WorldGate reached agreement withMototech, Inc. (not an affiliate of Motorola) for the purchase of 625,000shares of newly issued common stock at $0.80 per share, in return for futuredesign and engineering services by Mototech. WorldGate had previouslycontracted with Mototech to assist the Company with the design and volumemanufacture of WorldGate’s Ojo personal video phone. . Ascompensation for these shares the Company will receive an equivalent reductionin future development and initial procurement payments that would otherwise bedue to Mototech.  The value of thistransaction was $600 (based on the closing stock price of $0.96 on the date ofthe transaction) of which $200 was recorded as an expense for the year endedDecember 31, 2003.  The remaining $400was recorded as unearned compensation in stockholders equity section in theaccompanying balance sheet.  Mototech is an affiliate of Accton Technology Group,a group ofTaiwanese manufacturers that we believe are well-known in the electronicsindustry. Mototech currently manufactures anddistributes a full range of high performance high speed data and computernetworking products, including cable set top boxes, home gateways, wirelessLANs, hubs, switches, routers, and other related products. In addition, inApril 2004, Mototech invested $1,000 to purchase 666,666 shares of newly issuedcommon stock at $1.50 per share.

 

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# ITEM3.      QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.

 

Interest Rate Risk.  Our exposure to market risk related tochanges in interest rates relates primarily to our investment portfolio.  We invest in instruments that meet high creditquality standards, and we limit the amount of credit exposure with respect toany one issue, issuer and type of investment.

 

As of June 30, 2004, the Company’s cash andcash equivalents were $10,306, most of which were securities having a maturityof less than one year, and it had no short-term investments.  Due to the average maturity and conservativenature of our investment portfolio, management believes a sudden change ininterest rates would not have a material effect on the value of the portfolio.Management estimates that had the average yield of our investments decreased by100 basis points, our interest income for the six months ended June 30, 2004would have decreased by approximately $30. This estimate assumes that thedecrease occurred on the first day of 2004 and reduced the yield of eachinvestment instrument by 100 basis points. The impact on our future interest income of future changes in investmentyields will depend largely on our total investments.

 

Foreign Currency Exchange Risk.  Although we transact business in variousforeign countries, the principal portion of our current business is in theUnited States and substantially all of our costs to date have been denominatedin U.S. dollars.  Although our agreementwith Mototech (not an affiliate of Motorola), our contract manufacturer inTaiwan, is denominated in U.S. dollars, their material acquisition costs aresubject to exchange rate changes that could impact our production costs.

 

# ITEM4.      CONTROLS AND PROCEDURES.

 

In connection with Company’s preparation of the third quarter 200410-Q, our management, with the participation of our chief executiveofficer and chief financial officer, conducted an evaluation of theeffectiveness of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d -15(e) under the Securities Exchange Act of 1934, as amended(the “Exchange Act”)).

 

Basedon that evaluation, our chief executive officer and chief financial officerdetermined that we have a material weakness (as defined under the standardsestablished by the American Institute of Certified Public Accountants) thatexists with respect to our reporting of complex transactions. As a result ofthis material weakness, we restated our financial statements in our firstquarter 2004 Form 10-Q and this report.

 

The Company will evaluate the need to enhance its internal resources,including obtaining or engaging outside experts to address the accounting forcomplex transactions.  The Company willevaluate the findings of such experts in addressing these matters.

 

Asa result of the material weakness identified with respect to our reporting ofcomplex transactions, the chief executive officer and chief financial officerconcluded that our disclosure controls and procedures are not designed andeffective in ensuring that the information required to be disclosed by ourcompany in the reports that we file and submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms.  Except as identified above, therehave been no changes in our internal control over financial reporting thatoccurred during the quarter ended June 30, 2004, that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

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PARTII. OTHER INFORMATION

 

(DollarAmounts are in Thousands, Except per Share Amounts)

 

# ITEM 1.      LEGALPROCEEDINGS.

 

The Companyhas not paid its rent on its current facility since May 2003. As a result, ourlandlord, 3190 T General, Inc. in September 2003, filed an action in the Courtof Common Pleas, Bucks County Pennsylvania to perfect its interest to takepossession of our facility at any time, and to establish damages for past rentand expenses. In lieu of rent payments our landlord has drawn from our securitydeposit to satisfy the unpaid rent and such deposit has now been fullydepleted. A judgment was also granted allowing our landlord to regainpossession of the facility, although we remain in the facility, albeit insubstantially reduced space. During this process we attempted to negotiate asettlement of our lease obligation with the landlord in an effort to reduce ouroutstanding liability and secure the continued right to occupy the facilitywith a reduced ongoing lease obligation. We also worked with the landlord tosecure other tenants for the unused space. However, we were informed by thelandlord that this process was complicated by the requirement for the landlord’smortgage holder to approve any such amendments to our lease as well as anyarrangements with other prospective tenants. The landlord was not able toobtain such approvals from the mortgage holder and ultimately the landlord andthe landlord’s mortgage holder reached an agreement for the landlord’s mortgageholder to become a successor to the landlord’s interest in the property. Wehave already commenced negotiations directly with the mortgage holder’srepresentatives to secure the continued right to occupy the facility with areduced ongoing lease obligation, and are currently awaiting a proposal fromthe mortgage holder, although there can be no assurance that an agreement canbe reached with the mortgage holder. Concurrently we are exploring otherfacility opportunities in the event an agreement cannot be reached.

 

# ITEM2.     CHANGES IN SECURITIES AND USE OFPROCEEDS.

 

InstrumentsDefining the Rights of Holders of Our Registered Securities

 

OnJune 17, 2004, our board of directors authorized 7,550 shares of PreferredStock.  The rights, preferences andprivileges of holders of the outstanding preferred stock are subject to, andmay be adversely affected by, the rights of holders of shares of any additionalpreferred stock which we may designate and issue in the future.

 

The holders ofthe preferred stock may convert their shares into our common stock at aninitial conversion price of $2.35 per share. The conversion price adjusts inthe event of stock dividends and splits and certain distributions tostockholders, fundamental transactions, and future equity transactions. Thenumber of shares of common stock issuable upon conversion of the preferredstock increases with any accrued but unpaid dividends on the preferred stock,and changes in inverse proportion to the conversion price. We have the right torequire conversion of the preferred stock into common stock upon achievingcertain price targets with respect to our common stock and the satisfaction ofcertain other conditions.

 

The preferredstock has a dividend rate of 5% per annum, payable quarterly and in preferenceto the payment of any dividend on our common stock. The dividends may be paideither by cash or, subject to certain conditions, through the issuance ofcommon stock at our option (with stock payments being made at a 10% discount tothe then current market price). The preferred stock has a staged maturity overthree years with scheduled payments of one third due after 18 months, onehalf of the remainder due after 24 months and the balance due after36 months. The preferred stock may be redeemed at maturity in cash or,subject to certain conditions, through the issuance of common stock, at ouroption (with stock payments being made at the then current market price).

 

Upon anyliquidation, dissolution or winding up of our company, after payment of alldebts and liabilities of our company, but prior to any payment to the holdersof common stock, the holders of the preferred stock will be entitled to receivethe stated value of their preferred shares plus accrued but unpaid dividends. Holdersof the preferred stock generally have no voting rights, but are entitled toveto certain actions which would have the effect of changing, altering, ordiluting their shares. In connection with the issuance of the preferred stock,the Company agreed to indemnify the purchasers in connection with actions thatmay be instituted against them by our shareholders, except for actions basedupon a breach by such purchaser, violation by them of state or federalsecurities laws or fraud, gross negligence, willful misconduct or malfeasance.We do not believe such indemnification obligations are material to our Company.

 

 

Sales ofUnregistered Securities

 

(1)           On April 23, 2004,we completed a private placement of 666,666 shares of our common stock withMototech Inc. (not an affiliate of Motorola), at a sale price of $1.50 pershare. The private placement resulted in gross proceeds to us of $1,000.

 

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The commonstock was issued in reliance upon the exemption from the registrationrequirements of the Securities Act afforded to transactions not involving apublic offering by Section 4(2) of that Act and Rule 506 thereunder.

 

(2)           On April 28, 2004,we entered into a Development and Distribution Agreement with General InstrumentCorporation d/b/a the Broadband Communication Sector of Motorola, Inc., orMotorola. In connection with the Development and Distribution Agreement withMotorola, we issued a warrant to Motorola to purchase 300,000 shares of ourcommon stock at an exercise price of $1.4375 per share, and agreed to issueadditional warrants to purchase up to an additional 1,950,000 shares of ourcommon stock, upon the achievement of certain product and sales milestones, atan exercise price based upon the average closing sales price of our commonstock during the 20 day period preceding the issuance of each warrant.

 

The warrantswere issued in reliance upon the exemption from the registration requirementsof the Securities Act afforded to transactions not involving a public offeringby Section 4(2) of that Act and Rule 506 thereunder.

 

(3)           On June 11, 2004,we entered into an agreement with Sejin America to settle a dispute withrespect to certain inventory alleged to have been purchased by the Company. Inconnection with the agreement, we issued 39,035 shares of our common stock toSejin America in full settlement of the dispute. The common stock was issued inreliance upon the exemption from the registration requirements of theSecurities Act afforded to transactions not involving a public offering bySection 4(2) of that Act and Rule 506 thereunder.

 

(4)           On June 24, 2004,we completed a private placement of 7,550 shares of our preferred stock at asale price of $1000 per share, which preferred stock is convertible into ourcommon stock at a conversion price of $2.35 per share; five-year warrants topurchase up to 803,190 shares of our common stock at an exercise price of $2.69per share; and five-year warrants to purchase up to 803,190 shares of ourcommon stock at an exercise price of $3.14 per share. The investors alsoreceived an additional investment right, for a limited period of time, topurchase 1,606,383 additional shares of common stock shares at $3.14 a share.

 

The privateplacement resulted in gross proceeds to the Company of $7,550. The Company paidfees to Janney Montgomery Scott LLC, Ashenden Finance & Cie SA andSloan Securities LLC, based upon the proceeds received by the Company fromcertain of the Investors participating in this financing. The aggregate feespayable to these entities was less than six percent of the gross proceeds.

 

The preferredshares, warrants, and additional investment rights were issued in reliance uponthe exemption from the registration requirements of the Securities Act affordedto transactions not involving a public offering by Section 4(2) of thatAct and Rule 506 thereunder.

 

# ITEM3.     DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

# ITEM4.      SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.

 

None.

 

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# ITEM 5.     OTHERINFORMATION.

 

None.

 

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# ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K.

#  

(a) Exhibits.

 
| 3.1    |   | Amended and  Restated Certificate of Incorporation(1)                                                                                                                                                                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 3.2    |   | Amended and  Restated Bylaws(1)                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 3.3    |   | Form of  Certificate of Designations, Preferences and Rights of the Series A  Convertible Preferred Stock of the Company (2) (filed as Exhibit 3.1 to the  June 8-K)                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 4.1    |   | Form of  Series A Warrant dated as of June 24, 2004 issued by the Company to the  Investors (as defined in the Securities Purchase Agreement dated as of June  24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 4.2    |   | Form of  Series B Warrant dated as of June 24, 2004 issued by the Company to the  Investors (as defined in the Securities Purchase Agreement dated as of June  24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 4.3    |   | Form of  Series C Warrant dated as of June 24, 2004 issued by the Company to the  Investors (as defined in the Securities Purchase Agreement dated as of June  24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 10.1   |   | Development  and Distribution Agreement dated as of April 28, 2004 between the Company,  WorldGate Services, Inc. and General Instrument Corporation d/b/a the  Broadband Communication Sector of Motorola, Inc.(3) (filed as Exhibit 99.1 to  the July 8-K) (Portions of this agreement are subject to a confidential  treatment request.) |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 10.2   |   | Securities  Purchase Agreement dated as of June 24, 2004 by and between the Company and  the Investors (as defined therein)(2) (filed as Exhibit 99.1 to the June 8-K)                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 31.1   |   | Certification of Chief  Executive Officer Pursuant to Rule 13a-14(a).*                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 31.2   |   | Certification of Chief  Financial Officer Pursuant to Rule 13a-14(a).*                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 32.1   |   | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                        |
| 32.2   |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                           |

 

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*              Filedherewith.

 

(1)           Incorporated byreference to the exhibits to our Form 10-Q Report for the quarter endedMarch 31, 1999.

 

(2)           Incorporated byreference to the exhibits to our Current Report on Form 8-K datedJune 25, 2004 (the “June 8-K”).

 

(3)           Incorporated byreference to the exhibits to our Current Report on Form 8-K filedJuly 13, 2004 (the “July 8-K”).

 

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(b)                                 Reports on Form 8-K.

 

During the fiscal quarter ended June 30, 2004, the Company filed thefollowing Current Reports on Form 8-K:

 

On June 25,2004, a Current Report on Form 8-K was filed, reporting under items 5 and 7that the Company had completed a private placement of $7,550 of its PreferredStock and Warrants with several institutional investors.

 

SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|   |   |                   | WORLDGATE  COMMUNICATIONS, INC. |
|--------|--------|------------------------|---------------------------------|
|   |   |                   |                            |
|   |   |                   |                            |
| Date:  |   |  January 23, 2006 |                            | /s/ Hal M.  Krisbergh |   |
|   |   |                   |                            | Hal M.  Krisbergh |   |
|   |   |                   |                            | Chairman and  Chief Executive Officer |   |
|   |   |                   |                            | (Principal  Executive Officer) |   |
|   |   |                   |                            |   |   |
|   |   |                   |                            |   |   |
| Date:  |   | January 23,  2006      |                            | /s/ Joel  Boyarski |   |
|   |   |                   |                            | Joel  Boyarski |
|   |   |                   |                            | Executive  Vice President and Chief Financial Officer |
|   |   |                   |                            | (Principal  Financial and Accounting Officer) |

 

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